The Economic Survey of 2015-2016 has painted a gory picture on the state of the Indian economy with bankers and economists predicting another rough year ahead and a government that will only load the burden onto the middleclass in higher direct and indirect taxes.
The other option for the government is to increase its expenditure but that could risk rating downgrades by global agencies and turn detrimental to India’s image as far as foreign investments go. Besides, this option runs the risk of the government missing its FY17 fiscal deficit target of 3.5%.
The Economic Survey estimates a 7-7.75% growth rate but with an underlying caution to the downside. The equity and debt markets have discounted the slow growth rate and future high-tax regime as is evident from the downtrend in equity prices indices and the soaring bond yields.
The benchmark index, Nifty-50, has lost 15.14% or 1254.25 points since January 1, 2015 to 7029.75 as of February 26, 2016.
Ten-year bond yields have been trying to breach the 7.88% peak it hit this month and it’s only a matter of time before it breaches the 8% mark while the key RBI rate is 6.75%.
The Union Budget of Monday (Feb 29, 2016) will hence likely see a steep hike in service taxes from the present 14.5% to 16% and another round of excise duty hike from the present 12.5% coupled with some relief in tax slabs thrown in for the salaried. The year certainly will not see much of a job creation until early 2017.
Going by the declining participation of foreign institutional investors (FIIs) as well as foreign direct investments highlighted by the Survey, the government has no option but to hike direct and indirect taxes which in turn could push up domestic rates.
For the new fiscal, the government is burdened with Rs 1trillion expenditure to meet the 7th Pay Commission recommendations for government employees and the one-rank-one pension demand of retired defence personnel. These expenses will keep domestic interest rates buoyant even though government emissaries are propagating a 20-50 bps drop in RBI’s key rate of 6.75%.
It is likely that the government may phase out this `pay and pension’ hikes in a staggered manner to slowdown its fast depleting resources at one go, but that still leaves it with less income and more expenditure.
There are counter arguments to this too. A few market watchers hold the view that the government’s savings on global crude— most of which has been retained by the government ever since it began to slide from June 2014’s $105a barrel to the present $36—has led to a surplus of Rs 1.8 trillion. That still leaves the government with ample cash after adjusting the pay and pension hikes.Rs 1.8 trillion. That still leaves the government with ample cash after adjusting the pay and pension hikes.
But surely, a government that has been conservative when it comes to expenditure will not want to let go the money in one shot and it would rather focus on growth sectors where no bank is willing to fund purely due to long gestation periods. Roads, infrastructure and the latest being PSU oil companies that have announced a whopping Rs 3-4 lakh crore in new capacities could be possible triggers for a lift-off in activities in the new fiscal beginning this April.
But the early shoots of a turnaround in domestic economy will only be seen three quarters down the line beginning this April.
According to the Survey, net investment by FIIs in Indian markets has fallen dramatically by 67% or Rs 1.93 trillion to Rs 636.63 billion in 2015 as against the previous year’s Rs 2.56 trillion.
The next big hope for a lift-off is the monsoon. After two consecutive years of drought, a good monsoon this May-June should see a spurt in agro and allied sector activities.
“Given the global scenario, India is still in a better spot if we have a good monsoon this year,” said VK Vijayakumar, investment strategist at Geojit BNP Paribas.
“With 54% of the population depending upon agriculture and allied sectors, an encouraging monsoon could see a spurt in consumption expenditure,” he said.
Vijayakumar expects a 9% growth in the service sector, but does not rule out the impact of the sustained global slump on the country.
Meanwhile investment in government bonds by FIIs has diminished and that is keeping the rupee weak. The main reasons for the slump have been the hike in US Fed rate in December 2015 from near zero to 25 bps, the depreciating rupee and the expensive dollar-forward cover. The rupee has fallen from around 62 to the dollar in Jan 2015 to 68.72 currently.
This has removed the arbitrage benefit on the interest rate differential once enjoyed by FIIs owing to a stable rupee, a higher interest rate in India coupled with a near-zero Fed rate that they could borrow and fund their bond-buying.
Currently, six month forward cover on the dollar is 6.85%, add to it the current cost of borrowing in the US, which is, 1-1.25%, hence the entire exercise of FIIs borrowing cheap and investing in Indian debt, which is around 7.8%, has now diminished. The Survey has therefore has increased the FII limit on debt securities by another Rs 120,000 crore in a phased manner by March 2018 from Rs 153,000 crore.
But they remain unattractive unless rupee is stable and interest rates inch higher.